Question
Buffet Inc wishes to raise capital under a floating interest rate, as it would like to be able to take advantage of any fall in
Buffet Inc wishes to raise capital under a floating interest rate, as it would like to be able to take advantage of any fall in interest rates. It can borrow at a fixed rate of 4% or at a floating (LIBOR 1%) i.e. LIBOR rate minus 100 basis points. Gates Inc also wishes to raise external finance, preferably by issuing a fixed rate debt because they want certainty about their future interest payments, but can only borrow at 7% fixed or LIBOR + 1% floating. Assume both companies want to borrow the same amount in the same currency and there are no transactions costs (except the swap dealers fees). a) Develop an interest rate swap in which both Buffett Inc and Gates Inc have equal cost savings in their borrowing costs. Provide standard illustration (diagram) of payments in the swap, including the net payments for each counterparty to the swap. (15 marks) b) Introduce a swap dealer to the swap deal and illustrate (using the standard diagram) how he could earn a total of 0.1% spread (equally split across Buffett and Gates, the two swap counterparties). (5 marks)
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started